2007 Ruling 2006-0219051R3 - Loss-Utilization Proposal

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Is a loss utilization proposal involving a Holdco-Opco situation, within an affiliated group of corporations acceptable?

Position: YES

Reasons: Reasonable rate and quantum. Meets paragraph 32 of IT-533. No abuse or misuse of the Act read as a whole.

XXXXXXXXXX 								2006-021905

XXXXXXXXXX, 2007

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX ("Bidco") BN XXXXXXXXXX
Newco II
XXXXXXXXXX ("Target") BN XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-named taxpayers. In general terms, the transactions described herein involve the use of losses within an affiliated group of corporations. We also acknowledge information provided during numerous telephone conversations and electronic correspondences.

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues contained in this ruling request herein are:

(i) dealt with in an earlier return of Bidco, Target, Newco II or a related person;

(ii) being considered by a tax services office or a taxation centre in connection with a tax return already filed by Bidco, Target, Newco II or a related person;

(iii) under objection by Bidco, Target, Newco II or a related person;

(iv) the subject of a previous ruling issued by the Income Tax Rulings Directorate to the taxpayers or a related person; nor

(v) before the courts, or if a judgment has been issued, the time limit for appeal to a higher court has expired.

However, we understand that you have filed a request for advance income tax rulings regarding the acquisition of control of Target and the bump of the cost of capital property held by Target.

Legal Entity Definitions

In this letter, as in our letter 2006-019432 addressing your other income tax ruling request, the taxpayers will be referred to as follows:

(a) "Bidco" means XXXXXXXXXX, a corporation incorporated under the laws of XXXXXXXXXX, which is a Subsidiary Wholly-owned Corporation of BuyerSubco III and a TCC;

(b) "Buyerco" means XXXXXXXXXX, a corporation incorporated under the laws of XXXXXXXXXX and a tax resident of XXXXXXXXXX. The ordinary shares of Buyerco are listed on the XXXXXXXXXX stock exchanges;

(c) "Buyerco Group" means Buyerco and its subsidiaries;

(d) "BuyerSubco I" means XXXXXXXXXX, a corporation incorporated under the laws of XXXXXXXXXX , which is a Subsidiary Wholly-owned Corporation of Buyerco;

(e) "BuyerSubcoII" means XXXXXXXXXX, a corporation incorporated under the laws of XXXXXXXXXX and a Subsidiary Wholly-owned Corporation of BuyerSubco I;

(f) "BuyerSubco III" means XXXXXXXXXX, a corporation incorporated under the laws of XXXXXXXXXX and a TCC. BuyerSubco III is a Subsidiary Wholly-owned Corporation of BuyerSubco II;

(g) "BuyerSubco V" means XXXXXXXXXX, a corporation incorporated under the laws of XXXXXXXXXX. BuyerSubco V is a Subsidiary Wholly-owned Corporation of BuyerSubco III and a TCC;

(h) "Newco II" means a Subsidiary Wholly-owned Corporation to be formed by Bidco. Newco II will be incorporated under the XXXXXXXXXX as part of the Proposed Transactions. Newco II will be a TCC;

(i) "Target" means XXXXXXXXXX, a public corporation, as that term is defined in subsection 89(1). All the issued and outstanding common shares of Target are owned by Bidco and the outstanding and issued preferred shares of Target are listed on the XXXXXXXXXX Stock Exchange and are owned by the public;

(j) "Vendor" means XXXXXXXXXX;

(k) "Vendor Subco I" means XXXXXXXXXX, a corporation incorporated under the laws of Canada, which is a subsidiary wholly-owned corporation of Vendor; and,

(l) "Wco" means XXXXXXXXXX.

Definitions

In this letter, the following terms have the meanings specified:

(a) "ACB" has the meaning assigned to the expression "adjusted cost base" in section 54;

(b) "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof, and unless otherwise stated, every reference herein to a part, section, subsection, paragraph, subparagraph or clause is a reference to the relevant provision of the Act;

(c) "Agreed Amount" has the meaning assigned by subsection 85(1);

(d) "Affiliated Person" has the meaning assigned to the expression "affiliated person" in subsection 251.1(1);

(e) "Arm's Length" has the meaning assigned by subsection 251(1);

(f) "Canadian corporation" has the meaning assigned by subsection 89(1);

(g) "CRA" means Canada Revenue Agency;

(h) "FMV" means fair market value;

(i) "Non-capital Loss" has the meaning assigned by subsection 111(8);

(j) XXXXXXXXXX;

(k) "Proposed Transactions" means the transactions described in 26 to 39 below;

(l) "PUC" means "paid-up capital" and has the meaning assigned by subsection 89(1);

(m) "Subsidiary Wholly-owned Corporation" has the meaning assigned by subsection 248(1); and,

(n) "TCC" means "taxable Canadian corporation" and has the meaning assigned by subsection 89(1).

Unless otherwise specified, all dollar amounts are denominated in Canadian dollars.

Facts:

1. On XXXXXXXXXX, Buyerco, BuyerSubco III, Vendor, and Vendor Subco I, entered into a share purchase agreement pursuant to which BuyerSubco III purchased and Vendor Subco I sold XXXXXXXXXX common shares of Target owned by Vendor Subco I, representing approximately XXXXXXXXXX% of the common shares of Target. The purchase price was $XXXXXXXXXX per share, for an aggregate purchase price of $XXXXXXXXXX.

2. On XXXXXXXXXX, BuyerSubco III acquired XXXXXXXXXX outstanding Target common shares for $XXXXXXXXXX in cash XXXXXXXXXX.

3. On XXXXXXXXXX, BuyerSubco III paid for an additional XXXXXXXXXX common shares of Target (approximately XXXXXXXXXX% of Target's outstanding shares) XXXXXXXXXX with a cash consideration of $XXXXXXXXXX per share or approximately $XXXXXXXXXX.

4. On XXXXXXXXXX, Bidco paid for XXXXXXXXXX Target common shares, representing approximately XXXXXXXXXX% of Target's common shares with a cash consideration of approximately $XXXXXXXXXX.

5. On XXXXXXXXXX, Bidco paid for an additional XXXXXXXXXX Target common shares with a cash consideration of approximately $XXXXXXXXXX.

6. XXXXXXXXXX, Bidco took up XXXXXXXXXX Target common shares on XXXXXXXXXX and XXXXXXXXXX Target common shares on XXXXXXXXXX, for an aggregate cash consideration of approximately $XXXXXXXXXX.

7. On XXXXXXXXXX, Target purchased for cancellation XXXXXXXXXX Target common shares for $XXXXXXXXXX in cash. Further to this transaction, BuyerSubco III owns XXXXXXXXXX (XXXXXXXXXX%) of the Target common shares and Bidco owns XXXXXXXXXX (XXXXXXXXXX%) of the Target common shares.

8. On XXXXXXXXXX, BuyerSubco III transferred to Bidco, pursuant to section 85, all of its common shares of Target in consideration for common shares of Bidco.

9. As of the date hereof, Bidco owns XXXXXXXXXX common shares of Target representing XXXXXXXXXX% of the outstanding common shares of Target.

10. As of the date hereof, there are XXXXXXXXXX, preferred shares of Target presently issued and outstanding XXXXXXXXXX.

11. The amalgamation of Target and Bidco or (or a subsidiary of Bidco) may be completed pursuant to a plan of arrangement so long as the Target preferred shares are outstanding. Alternatively, the outstanding Target preferred shares are all redeemable by XXXXXXXXXX, after which, the amalgamation could be completed without a plan of arrangement.

12. The acquisitions described in 3 to 6 above were financed as described in 13 to 24 below.

13. XXXXXXXXXX, BuyerSubco I made, pursuant to a credit facility between BuyerSubco I and BuyerSubco III, an interest-bearing loan of approximately $XXXXXXXXXX to BuyerSubco III.

14. XXXXXXXXXX, BuyerSubco III used the proceeds of the loan from BuyerSubco I to make an interest-bearing loan of $XXXXXXXXXX to Bidco.

15. XXXXXXXXXX, BuyerSubco II made, pursuant to a credit facility between BuyerSubcoII and BuyerSubcoIII, a non-interest bearing loan of approximately $XXXXXXXXXX to BuyerSubco III.

16. BuyerSubco III used approximately $XXXXXXXXXX to pay for the Target common shares acquired in 3 above and made a non-interest bearing loan of approximately $XXXXXXXXXX to Bidco.

17. On XXXXXXXXXX, BuyerSubco V issued US$XXXXXXXXXX (or approximately $XXXXXXXXXX ) of bonds XXXXXXXXXX.

18. BuyerSubco V used the US$XXXXXXXXXX proceeds from the issuance of the bonds to make an interest-bearing loan of approximately $XXXXXXXXXX to Bidco.

19. Bidco used the $XXXXXXXXXX received from BuyerSubco V to repay approximately $XXXXXXXXXX of Bidco's interest-free loan from BuyerSubco III, which repaid approximately $XXXXXXXXXX of its interest-free loan from BuyerSubco II.

20. On XXXXXXXXXX, approximately $XXXXXXXXXX of the non-interest bearing loans from BuyerSubco II to BuyerSubco III was assigned by BuyerSubco II to BuyerSubco I.

21. On XXXXXXXXXX, BuyerSubco I and BuyerSubco III agreed that approximately $XXXXXXXXXX of the non-interest bearing loan would become an interest bearing loan.

22. On XXXXXXXXXX, BuyerSubco III and Bidco agreed that approximately $XXXXXXXXXX of the approximately $XXXXXXXXXX non-interest bearing loan outstanding would become an interest bearing loan.

23. On XXXXXXXXXX, BuyerSubco III issued approximately XXXXXXXXXX preferred shares for $XXXXXXXXXX per share to BuyerSubco II in settlement of the balance of the non-interest bearing loan due to BuyerSubco II.

24. On XXXXXXXXXX, Bidco issued approximately XXXXXXXXXX common shares to BuyerSubco III in full payment of the approximately $XXXXXXXXXX interest-free loan outstanding from BuyerSubco III.

25. The PUC of Target's common shares is estimated to be approximately $XXXXXXXXXX.

Proposed Transactions

26. Bidco will incorporate Newco II, under the XXXXXXXXXX and will subscribe for common shares for a nominal amount. Newco II's authorized share capital will consist of an unlimited number of common shares and preferred shares (the "Newco II Preferred Shares"). Each common share of Newco II will entitle the holder to one vote. The holder of Newco II's common shares will be entitled to receive dividends if, as and when declared at the discretion of Newco II's directors, and will be entitled to receive the remaining property of Newco II upon its winding-up or dissolution. The Newco II Preferred Shares will have the following attributes:

a) non-voting;

b) entitled to a cumulative dividend at an annual rate of XXXXXXXXXX%;

c) redeemable at the option of holder for an amount equal to the issue price plus any accrued but unpaid dividend, by Newco II;

d) retractable at any time at the option of the holder for an amount equal to the issue price plus any accrued but unpaid dividends; and,

e) entitled to priority over the common shares of Newco II and all other shares ranking junior to the Newco II Preferred Shares with respect to the payment of dividends and the distribution of assets of Newco II in the event of any liquidation, dissolution or winding-up of Newco II or the other distribution of assets of Newco II among its shareholders for purposes of winding-up its affairs.

27. Target will borrow an amount of approximately $XXXXXXXXXX on a "daylight loan" basis from an Arm's Length financial institution (the "First Daylight Loan ").

28. Target will use the proceeds of the First Daylight Loan to subscribe for $XXXXXXXXXX of Newco II Preferred Shares. The Newco II Preferred Shares will be redeemable for an aggregate amount equal to the principal amount of the First Daylight Loan, plus any accrued but unpaid dividends. The aggregate PUC of the Newco II Preferred Shares will be equal to the principal amount of the First Daylight Loan.

29. Newco II will lend the $XXXXXXXXXX of proceeds it receives from the issuance of the Newco II Preferred Shares to Bidco on a demand non-interest bearing basis (the "Bidco Loan").

30. Bidco will lend the $XXXXXXXXXX of proceeds it receives from the Bidco Loan to Target on a demand basis (the "Target Loan "). The Target Loan will bear interest at an annual rate of XXXXXXXXXX%. Target will use the proceeds of the Target Loan to repay in full the First Daylight Loan.

31. To the extent that, on the date dividends are to be paid by Newco II on the Newco II Preferred Shares, Newco II does not have sufficient cash on hand, or is not able to legally pay dividends, Bidco will contribute such additional funds to Newco II in the form of a contribution of capital as are required to enable the payment of such dividends. No shares will be issued by Newco II with respect to these contributions of capital and no amount will be added to Newco II's stated capital accounts or to its PUC. The amount of each contribution of capital will be recorded by Newco II as contributed surplus for accounting purposes. Contributions of capital will not be treated as income of Newco II pursuant to generally accepted accounting principles in Canada.

32. Newco II will pay dividends to Target equal to the amount of dividends payable on the Newco II Preferred Shares in accordance with their terms.

33. The following transactions will occur in order to unwind the loss utilization arrangement immediately before the amalgamation of Target with Bidco or a newly incorporated subsidiary of Bidco:

a) Bidco will make a contribution of capital to Newco II in an amount equal to the amount of any accrued and unpaid dividends on the Newco II Preferred Shares held by Target. No shares will be issued by Newco II and no amount will be added to its PUC in respect of the contribution. The amount of this contribution of capital, if any, will be recorded as contributed surplus for accounting purposes. The contribution of capital, if any, will not be treated as income of Newco II pursuant to generally accepted accounting principles in Canada;

b) Target will borrow $XXXXXXXXXX on a "daylight loan" basis from an Arm's-Length financial institution (the "Second Daylight Loan "). Target will use the funds received from the Second Daylight Loan to repay in full the Target Loan owed to Bidco;

c) Bidco will use the funds received from Target on the repayment of the Target Loan to repay in full the Bidco Loan owed to Newco II;

d) Newco II will use the funds received from the transactions described in subparagraphs (a) and (c) above to redeem the issued and outstanding Newco II Preferred Shares held by Target;

e) Target will use the proceeds of the redemption of the Newco II Preferred Shares described in subparagraph (d) above to repay in full the Second Daylight Loan and pay any unpaid interest thereon; and,

f) Newco II will be wound-up into Bidco and Newco II will later be dissolved.

Purpose of the Proposed Transactions

34. In general terms, the transactions described herein involve a loss utilization transaction within an affiliated group of companies which will permit Target to deduct the losses that would otherwise be incurred by Bidco in respect of interest payable on borrowed money, the proceeds of which were used to partly finance the acquisition of the shares of Target. The purpose of the Proposed Transactions is to allow for the consolidation of the Non-capital Losses of Bidco that would have been created by the interest expense, if it were not for the loss utilization transaction as described above, with the taxable income of Target. The loss utilization arrangement will be put in place because there are certain legal reasons which inhibited Target's ability to amalgamate with Bidco or a newly incorporated subsidiary of Bidco at this point in time. The loss utilization arrangement will be put in place until Bidco, or a newly incorporated subsidiary of Bidco, can amalgamate with Target.

35. The purpose of Bidco making the capital contributions to Newco II as described in 31 and 33a, as opposed to having Bidco subscribe for additional common shares of Newco II, is to ensure that Newco II will not be precluded from declaring dividends on the Newco II Preferred Shares XXXXXXXXXX. If additional common shares of Newco II were subscribed for and issued, the realisation value of Newco II's assets after the payment of such a dividend would be less than the aggregate amount of its liabilities and stated capital of its common shares and Newco II Preferred Shares.

Additional Information

36. The Proposed Transactions described herein will occur in the order presented unless otherwise indicated.

37. Each of the corporations involved in the Proposed Transactions is a "specified financial institution" as defined under subsection 248(1) because they are related to a captive insurance company of the Buyerco Group.

38. Newco II will not be used for any purposes other than those described in the Proposed Transactions. Bidco will not elect, at any time, to claim a capital loss in respect of its investment in Newco II. Also, as Newco II will not have any debt, it should never be insolvent.

39. None of the corporations involved in the Proposed Transactions has or will have entered into a "dividend rental arrangement" as defined by subsection 248(1).

40. In the Proposed Transactions, there is no refreshing of losses.

41. Target has permanent establishments in XXXXXXXXXX and XXXXXXXXXX, respectively, of its taxable income is allocable to those provinces based on Target's XXXXXXXXXX income tax returns.

42. Bidco has a permanent establishment only in the province of XXXXXXXXXX.

RULINGS GIVEN:

Provided that the preceding statements constitute complete and accurate disclosure of all the relevant facts, the Proposed Transactions and purpose of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, we rule as follows:

A. Provided the interest paid or payable by Target on the Target Loan is reasonable and is paid pursuant to a legal obligation to pay interest and that the Newco II Preferred Shares continue to be held by Target for the purpose of gaining or producing income from property, Target will be entitled to deduct, pursuant to paragraph 20(1)(c) of the Act, the interest paid or payable on the Target Loan in respect of the taxation year to the extent such amount does not exceed a reasonable amount.

B. In respect of the contributions of capital made by Bidco as described in 31 and 33a above, no amount will be included in the income of Newco II pursuant to section 9 or paragraphs 12(1)(c) or 12(1)(x) of the Act.

C. The dividends (or deemed dividends, if any) received by Target on the Newco II Preferred Shares, as described in 32 above (or if any, as a result of the transaction indicated in 33d above), will be taxable dividends that will be deductible pursuant to subsection 112(1) of the Act in computing the taxable income of Target for the taxation year in which the dividends are received, and, for greater certainty, such deduction will not be precluded by any of subsections 112(2.1), 112(2.2) or 112(2.4) of the Act.

D. Subsection 245(2) of the Act will not be applicable as a result of the Proposed Transactions to redetermine the tax consequences confirmed in the rulings given above.

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and are binding on the CRA provided that the Proposed Transactions, excluding 33 above, are completed by XXXXXXXXXX.

The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

COMMENTS

Nothing in this ruling should be construed as implying that the CRA has agreed to, reviewed or has made any determination in respect of:

(a) the FMV or ACB of any property or the PUC of any shares referred to herein;

(b) the amount of any non-capital loss, net capital loss or any other amount of any corporation referred to herein;

(c) the provincial income tax implications relating to the allocation of income and expenses under the Proposed Transactions;

(d) the application or non-application of the general anti-avoidance provisions of any province; nor

(e) any tax consequences relating to the facts and Proposed Transactions described herein other than those specifically described in the rulings given above.

Yours truly,

XXXXXXXXXX
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch